Server Sales Drive Revenue Increase for Microsoft

by Alex Woodie

Continued strong sales of Windows Server 2003, Exchange Server, and SQL Server helped offset a less than stellar showing from Microsoft's client operating system and application businesses for the third quarter of fiscal 2005. While revenue in the software giant's Client business increased a paltry $63 million to $2.99 billion, the Server and Tools business increased by $254 million to $2.4 billion, a 12 percent increase.

When you're the largest software company in the world, even a poor quarter in the eyes of Wall Street aren't really so bad after all. Such was the case last week, when Microsoft reported its third-quarter revenue and income figures, which weren't as rosy as some had hoped.

Overall, the Redmond, Washington, software company reported $9.6 billion in revenue, a 5 percent gain from the third quarter of fiscal 2004. Net income came in at $2.56 billion and $0.23 per share, practically double the $1.32 billion profit and $0.12 per share the software behemoth brought in last year, when it made a big $2.53 billion payout to settle some legal problems. This year, those payouts only amounted to $768 million. You might be happy if every third dollar that came into your company was pure profit, but Wall Street expected better revenue figures.

If a bright spot is needed in this otherwise indistinguishable sea of mediocrity, consider Microsoft's server division. "In addition to the benefit to revenue associated with year over year favorable exchange rates, revenue growth was driven primarily by another strong performance in our server and tools business, which had growth of 12 percent, the 11th consecutive quarter of double-digit revenue growth for this business," said Curt Anderson, general manager of Microsoft's investor relations department, during the earnings conference call last Thursday.

The Server and Tools division continued its string of profitable quarters recording a net income of $824 million on that $2.4 billion revenue, a 34 percent boost from the $616 million it brought in last year. This growth is driven by the two big stars in the server division, SQL Server and Exchange, which grew revenues by 15 percent and 20 percent, respectively.

Those numbers could have been better, but server sales slowed. "We estimate that during the quarter total server hardware unit shipments grew at 9 percent, which is lower than our projections of 15 percent," Anderson said. "Windows unit hardware shipment grew in line with overall market growth."

While Wall Street wasn't particularly happy with the quarter, Microsoft did its best to downplay the less -than stellar numbers. "The quarter played out largely as expected," Anderson said. "Our slight revenue miss was driven primarily by the combination of unfavorable [foreign] exchange movements, which we gave you guidance of in January, and a greater than expected decline in commercial and retail licensing in the Client business."

The Client business remains a bastion of revenue generation and profitability--about $2.34 billion of its $2.99 billion in revenue was net income--but other Microsoft businesses are not nearly as robust or healthy. In terms of profitability, the Microsoft Business Solutions division is a drag on the rest of the business. MBS recorded a scant 3 percent increase in revenue to $185 million, while increasing its loss from $52 million to $54 million, making it the only Microsoft division to lose more money this quarter than it did during the same quarter a year ago. The Home and Entertainment division, another developing business for Microsoft, showed some life last quarter, with revenue increasing about 12 percent to $593 million, and losses narrowing from $209 million last year to $154 million this year.

Looking forward, Microsoft expects the fourth quarter of fiscal 2005 and fiscal year 2006 to continue to change in much the same way that they have been changing, with continued double-digit growth in the Server and Tools business, and difficulty in the Client division, where software piracy in developing nations will continue to take a bite out of revenues and profits.

Scott Di Valerio, corporate vice president and corporate controller for Microsoft, says the company expects 10 to 12 percent growth in the Server and Tools division for the fourth quarter, with growth of 8 to 9 percent in the Client business. "We continue to expect full year server shipments to grow 13 to 15 percent and we expect the Windows server platform to grow faster than the overall server segment," he said.

Overall, Microsoft is forecasting revenues of $10.1 billion to $10.2 billion for the fourth quarter, which would correspond with growth of 8.6 percent to 9.6 percent over the $9.3 billion the company posted for the fourth quarter of fiscal year 2004. For fiscal year 2006, the company is forecasting total revenue in the range of $43.3 billion to $44.1 billion, which would be about a 9 percent increase over the $39.7 to $39.8 billion in total fiscal year 2005 revenues it expects to bring in by June 30. "In short, business was good, and solid business fundamentals remain in place which is reflected in our guidance for the fourth quarter and fiscal '06," Di Valerio says.